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Wednesday, 2 November 2011

Giant vampire paella

MF Global, run by ex-Goldman senior partner Jon Corzine filed for bankruptcy last week. Corzine led MF Global into large positions on European sovereign debt. As plays on margin/yields, these only worked because of the large amount of leverage that he used. At the end of June, MF Global had borrowed $44.4 billion on $1.4 billion of equity.

The essence of the strategy was that there were severe discounts on some European government paper, and that by leveraging up with debt the firm could make a profit. Many of the Italian and Spanish bonds held by MF Global will mature in the next 2 years and are trading at less than 2% below par, but the firms built its position on the back of short-term funding and when that dried up (at least at a rate that made the trades profitable) the game was up. But whichever way you look at it, the deals never made sense. If the firm held mostly European government paper why should its funders charge any less than the yield on that paper? Given the other costs and potential for screw ups, they should be charging more. Which was why the firm couldn't find funding and went bust.

Corzine was at Goldman Sachs for nearly 25 years, rising to senior partner before being thrown outin a boardroom coup in 1999. He was a star trader who made winning bets, but somehow he seems to have made an elementary mistake. How did a former Goldman star makes such an elementary mistake? The answer is probably that it was never the star traders at Goldman who made the money but the risk management. After all, for most of its history the firm ran as a partnership, and while there may have many on the trading floor who put themselves forward as masters of the universe, it was the partners who were putting their own capital at risk. Not making a lot of profit is no fun, but it beats losing your shirt.

The proof of the calibre of Goldman trading stars versus the Goldman risk managers shows up when we look at other ex-Goldmen. John Thain, former Goldman CFO was fired by Merrill Lynch after they disclosed substantial losses. Thain had gone through the ML books in detail and them signed off, buut less than 12 months later, Merrill was in peril, sold to BofA and Thain was shown the door.

Robert Rubin, another star trader, went from being co-chairman of Goldman to Treasury Secretary and then went back to Wall Street to sit on the board of Citigroup as a senior adviser in the late 90s. Rubin best demonstrated the value of advice from traders. His advice: "Take more risk". Citibank, let us not forget, was renowned for its training programme, for its foreign exchange trading and its pre-eminence in loan syndication. The other side of Citigroup, the ex-Salomon, Smith, Barney, Travellers etc, probably needed no encouragement to take more risk, but needed to be kept under control. While Rubin was at Citi, its share price fell by 70%.

Another famous ex-Goldman star was J C Flowers, who left Goldman Sachs to set up his own fund to invest in financial institutions. At first he did well, making more than $1 billion on LTCB (now Shinsei Bank), but his latest fund has lost $4 billion of investors money, including quite a bit on MF Global.

But hey, in most of these cases, it was all OPM, and a one-way bet that didn't pay off. At least for the equity investors like Flowers whose money is now toast, or rather lunch for the bankers whose loans will now be extended and paid out by the underlying bonds.

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